Cooling Down China

In its attempt to encourage commercial banks to be more tight-fisted with lending, China’s central bank upped the reserve requirement once again by another 50 basis points. Recall that the People’s Bank of China already employed this move mid-January when they raised the reserve requirement by the same percentage.

It seems that China is really hell-bent on making sure inflation doesn’t surge to uncontrollable levels. And why wouldn’t China be worried? You see, unlike the banks in the US and in Europe, China’s banks refrained from investing heavily in mortgage-backed securities. They are, however, heavy on household and commercial lending. Recent reports on economic activity showed that both Chinese households and businesses have been borrowing immensely from banks.

Just last month, a report revealed that the average price of apartments went up by a whopping 9.5% year-on-year, marking the biggest increase in almost two years. The producer price index for the same month showed that manufacturers spent twice as much for their supplies from the previous month, indicating that consumer prices could soon follow.

If you still want more evidence, take look at bank lending last month. All in all, commercial banks lent a grand total of $203.4 billion in January, the third largest amount since the Chinese official started recording data. I could go on and on but I think you get the picture!

As I’ve said in my last article about China, Chinese officials fear that a new bubble could be forming and that inflation may get out of hand. In case you do not know, by raising the reserve requirement for banks, they are forced to keep more cash in reserves, which they could otherwise be lent out. Naturally, with lesser access to credit, the rate at which businesses can grow is slowed down, capping excessive economic expansion.

Come February 25 when the change in policy takes effect, the reserve requirement for large banks and small banks will be 16.5% and 14.5%, respectively.

Last Friday, news of China’s order to increase the reserve ratios banks pulled the global equities markets and the higher yielding currencies back in the red. Remember that China is the second biggest economy in the world. Cooling down its economy could unfavorably impact the global economy as a whole.

Limiting their expansion would, in the same way, put a cap on the businesses of their major trading partners like the US and Australia. Moreover, since a lot of Chinese banks have become major lenders in the world, increasing their reserve requirements would effectively limit liquidity in the global financial markets as well.

Despite China’s recent measures to cool down its system, the Chinese economy is still expected to post a handsome 10% growth in the next quarter fueled by a robust export demand, strong domestic consumption, and increased government spending. Some Western economists even predict a GDP growth of about 12%. For the first time ever, China is now playing a leading role in stabilizing the global economy. Given this act, expect the market to keep an eye on its every move.

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